Rules on bank risk in mortgage bonds being adopted

WASHINGTON — Federal regulators are proceeding with new rules that ease guidelines for banks selling mortgage securities and could mean fewer borrowers will need to make hefty down payments.

The Securities and Exchange Commission voted 3-2 Wednesday to adopt the rules, which six federal agencies have been working on since 2011. The SEC’S two Republican commissioners, Daniel Gallagher and Michael Piwowar, opposed adoption. The Federal Reserve governors approved the rules on a 5-0 vote later in the day. Three other agencies adopted the rules Tuesday.

With the financial crisis and subprime mortgage bust receding further into history, the regulators are looking to inject more life into the still-recovering housing market.

The rules govern the amount of risk banks must take on when they package and sell mortgage securities in a multitrillion-dollar market. In the final rules, the regulators have dropped a key requirement: a 20-percent down payment from the borrower if a bank didn’t hold at least 5 percent of the mortgage securities tied to those loans on its books.

The final rules include the less stringent condition that borrowers not carry excessive debt relative to their income.

The rules for the market for mortgage securities will take effect in a year. For other kinds of securities such as those bundling together auto loans or commercial loans, which don’t allow banks an exemption from the 5-percent rule, the effective date is in two years.

The rules were mandated by the overhaul law enacted in the wake of the 2008 financial crisis. The idea was to limit the kind of risky lending that brought on the crisis. If banks have more of their own money invested in mortgage securities – so-called “skin in the game” – they won’t be as likely to take excessive risks, the thinking goes.

Fed Chair Janet Yellen said at Wednesday’s meeting that “skin in the game” requirements give banks selling securities an economic incentive to monitor the credit quality of the loans tied to them.

SEC Chair Mary Jo White said the regulators have found a balance between two objectives of the financial overhaul law: “protecting investors and not unnecessarily inhibiting the residential mortgage market.”

Some critics warn that abandoning the 20-percent down payment condition could bring a return to the dangerous days of borrowers taking on heavy mortgage loans that they aren’t in a position to repay. Industry groups, meanwhile, are talking up the eased rules’ potential impact on lending.

After three years of interagency haggling, the regulators’ final, compromise approach was to adopt the Consumer Financial Protection Bureau’s definition of a “qualified” mortgage. It excludes the kind of risky practices that fueled the crisis, such as mortgages issued without any supporting documents from borrowers.

Gallagher said before the SEC vote that the six agencies have “disgracefully abdicated to the Consumer Financial Protection Bureau.” He said the new rules could have “dire consequences” by encouraging the kinds of risky lending practices that helped spark the financial crisis.

Republicans have strongly opposed the CFPB, which was created by the 2010 overhaul law, and Republican lawmakers had sought to curtail the agency’s powers.